How (and why) do regions grow?

There are many different approaches to regional economic development – ranging from education-led (every region wants a university campus), population led (from Busselton to Trundle), infrastructure-led (classic ‘build it and they will come’ optimism), innovation-led (joining up researchers, innovators and creative business people) right through to subsidy-led ‘smokestack chasing’ where large employers are offered generous incentives (at taxpayer expense) to locate to a particular region. All of these are in play in Australia at present, and all are well tried and tested in the US, Canada and Europe too. With so much at stake, is there any evidence as to what works, and what actually makes regions (as opposed to capital cities) grow?

The OECD did a major study into what drives regional growth in 2009 (How Regions Grow: Trends and Analysis) which combined quantitative and qualitative analysis to identify the drivers of regional growth in OECD member countries. The study found four main actions stimulate regional growth:

1. Provide infrastructure as part of an integrated regional approach. The analysis suggests that infrastructure alone has no impact on regional growth unless regions are endowed with adequate levels of human capital and innovation. In other words, infrastructure is a necessary, but insufficient, condition for growth. The analysis also reveals that it takes about three years for infrastructure to positively influence growth.

2. Invest in human capital. Regions with well-educated populations will grow. Investments in tertiary education take about three years to have a positive impact on regional growth.

3. Emphasise innovation and research and development. Investments in R&D have a positive effect on patent activity in all categories, as do R&D expenditures by businesses, the public sector, higher-education institutions and the private non-profit sector. However, innovation is a longer-term process and appears to have a positive influence on regional growth only after five years.

4. Focus on integrated regional policies. Sources of growth from within regions, such as human capital and innovation, are more important than a region’s physical distance from markets. Although a region with good accessibility to markets has an added advantage, its growth depends on the presence of human capital, innovation, infrastructure and economies of agglomeration. Regions perform well when local actors in a regional innovation system can communicate easily with each other. (p17)

There are a lot of lessons in here.

Firstly, think about the implications of the findings on infrastructure. It’s still touted here as a saviour (recall the promises for opening up northern Australia before the election?) but the actual findings are that it does nothing without “adequate levels of human capital and innovation”. So it doesn’t pay to push infrastructure too far ahead of these two other crucial factors. In fact a key finding from the study was that all interventions to promote growth need to be carefully targeted and sequenced. For example, while education and infrastructure are both important in regional growth, over-investment in transport infrastructure may well lead to mass movement of people out of a target region to live or work, if the work and education opportunities are not perceived as being adequate. Conversely, over-investment in education without appropriate levels of investment in infrastructure and suitable job availability may well lead to residents leaving the target region after education to chase work elsewhere.

Secondly, human capital has now been shown to have a measurable impact on rates of regional economic development. Formal training and education, and on-the-job skills building are all crucial. The connection is that workers can’t keep doing the same things the same way and expect to drive growth. Individual skills, and connections between people (workers, managers, financiers) are all aspects of human capital that need to be functioning at a high level for a region to grow. The OECD study found that labour markets are also important for fast-growing regions, especially when labour supply and labour demand increase simultaneously (as in Australia’s mining regions up until a year or so ago). The OECD found “higher regional growth when the employment rate, the participation rate and the activity rate improve simultaneously”.

Thirdly, innovation is a popular policy package at the moment in Australia, and one which can take many different forms. The OECD work found that it is indeed important, but that it takes five years and more for increases in innovation activity (incremental innovations as well as new processes and inventions) to translate into measurable economic growth. Innovation, when done well and integrated with human capital and labour markets, can be a real driver for productivity, which is one of the foundations of sustained economic growth.

Lastly, growth is all about getting all the puzzle pieces to work together. It takes more than a good offer in any one of the important parts, and location alone need not be a key determinant. Almost every region I’ve worked with has trumpeted their ‘centrality’ – between two or more major markets and/or their proximity to major transport infrastructure or destination markets. But from a business point of view only a handful of these locations have seen any real private sector investment that capitalises on these supposedly ‘central’ locations. This is partly because from a commercial point of view, some areas are in fact more central than others. And it is also because even if the geographical location is actually a winner, matters of labour availability and skills, and quality of local supplier businesses are also taken into account. Location is but one piece in the puzzle, and from a potential investor’s point of view the more pieces of the puzzle that are connected the better.

The OECD report puts it neatly: “Regions perform well when local actors in a regional innovation system can communicate easily with each other.”

In regions I’ve worked with it is rare for the public sector actors to communicate, let alone coordinate across their different responsibilities. And it is even rarer for the public and private sectors to communicate well. A natural disaster can be the breakthrough needed – but at a price. Even communication and collaboration amongst businesses is rare, though a home-grown business cluster, driven by local business owners looking to get more out of collaborating somehow, is often invisible. So the challenge is to improve cross-actor communication, but not by trying to control that communication, and not by getting in the way of things that might be invisible but working quite well.

The OECD work notes that there is a perception (especially in Europe) that policies should either be pro-equity or pro-efficiency, and that a tradeoff is inevitable. This reflects the political view that some regions need to be helped because they are falling behind (pro-equity) while others, if helped, have the capacity to grow faster and contribute to wider economic growth ambitions (pro-efficiency). But the report found that in fact, given the relatively small and now well-understood set of drivers noted above, national governments can and should promote growth in all regions. Cross regional collaboration seems to help neighbouring regions grow as well. And in fact, the OECD notes, it is not just up to government to drive growth anyway, and it acknowledges that local action is at least as important as the national handout.

“Regions should promote their own growth by mobilising local assets and resources so as to capitalise on their specific competitive advantages, rather than depending on national transfers and subsidies to help them grow.”

These are good lessons for Australia, well researched and well-documented. The findings are particularly timely as our new national government starts to come to grips with the challenges of supporting growth in regional Australia – moving beyond election-winning headline grabbers about ‘developing the north’ to actually influencing and stimulating growth in Australia’s regions.

Economic Modelling – shining light on a dark art

Economic modelling has been likened to driving forwards while looking only in the rear vision mirror, as it can only use historical data and this can be a poor guide to what will happen in the future. Economic forecasting (modelling with more courageous assumptions) has been described as an activity invented to make fortune telling look respectable. These light-hearted definitions are based on the poor record that economic analysis has in predicting the future, especially in the many cases where the future does not continue a trend visible in the recent past. Economic models are based on long run relationships and ratios, and on some strong underlying assumptions that constrain human behaviour and decision–making. Were these constraints removed, it is often perceived that modelling would be too inconclusive to be useful.

Input-output approaches
The regional input output approach is the most common way of building a predictive model of how a regional economy will react to external shocks. Unfortunately, while input-output models have been used effectively at the national scale, at the regional and local scale they cannot reflect enough of the local specialisations, strengths and weaknesses to be reliable. A regional-scale input-output approach known as Generating Regional Input-output Tables (GRIT) is in common use, and a study for the Cotton Catchment Communities CRC in 2008 noted a series of limitations (my comments in bold):

1. A linearity assumption implies that any change has proportionate effects throughout the economy so that there are no substitutions among inputs and products. Implication – fixed supply chains from paddock to export mean that the model cannot respond to adaptation and seasonal variation, for example by reducing need for labour through capital equipment.

2. A set of homogeneity assumptions mean that all of the entities (eg farms) in the specified sectors are the same in terms of production technology, products produced, goods consumed, etc. Implication – model eliminates adaptation amongst growers and between growers.

3. There is no consideration of market effects in the input-output model and all results are based on real changes in production of goods and services. Implication – models allows for no feedback between price signals (and more importantly for growers price expectations and forecasts) and cropping behaviour.

The exclusion of price-reactions in input-output models and the inherent assumption that the main ‘factors of production’ (land, labour and capital) are not constrained are the major criticisms of them levelled by economists.

“The rigidity of input output tables and their inability to conform to the most basic of economic assumptions about the role of price in the economy means that input output modelling should only be used to evaluate relative small changes in the economy.” (Denniss, 2012)

“Multipliers assume that extra output can be produced without constraints on the supply of labour, capital, land, good or service. The factors of production are assumed to be limitless in supply and therefore can be sourced without any price increase.” (WA Treasury, 2002)

Regional input-output models are often used to quantify the flow-on effects through a regional economy of an external ‘shock’ such as a change in commodity prices, labour costs or energy prices. The flow-on effects are estimated by considering the ‘multipliers’ through the regional economy, multipliers which are part of the regional input-output model and which link the inputs into an industry from other industries, and the output from an industry into others. While still widely used, these multipliers are highly misleading and are no longer published by the ABS as they have been used inappropriately:

“While Input-Output multipliers may be useful as summary statistics to assist in understanding the degree to which an industry is integrated into the economy, their inherent shortcomings make them inappropriate for economic impact analysis. These shortcomings mean that Input-Output multipliers are likely to significantly over-state the impacts of projects or events.” (ABS, 2009 )

Economists criticise the results of input-output modelling when used to demonstrate the significance of an industry and the impact of its expansion or contraction:

“While multipliers can be a useful way of summarising and quantifying interlinkages within the economy, they are more often abused than used correctly. Multipliers are used to suggest that an industry is more valuable to Western Australia than its current size would suggest. They are used to show substantial flow-on benefits to the broader economy and to justify claims for government support for that activity. However, multipliers do not provide a measure of net economic benefit of expanding activity in a particular area. They are based on limiting assumptions and dated information.” (WA Treasury 2002)

“Claims that jobs ‘gained’ directly from the cause being promoted will lead to cascading gains in the wider economy often fail to give any consideration to the restrictive nature of the assumptions required for input-output multiplier exercises to be valid. In particular, these applications fail to consider the opportunity cost of both spending measures and alternate uses of resources, and may misinform policy-makers.” (Gretton, Productivity Commission 2013 )

In April 2013 these criticisms were noted in a landmark case in the NSW Land and Environment Court. Rio Tinto applied for an extension at its Warkworth Mine, and the extension was denied by Justice Preston, in part because the proponents overstated the positive impact of the expansion on the regional economy. Justice Preston noted that”

“… employment generated from the extension of the Warkworth mine would involve currently employed skilled workers transferring from other industries, but the vacancy thereby created in the other industries may not necessarily be filled, partly because of a shortage of skilled workers and partly because the remuneration is inferior to that offered in the mining industry.“ (judgement, para 460 )

In other words, the input-output multiplier calculations did not take account of the state of the Hunter labour market, and that all those extra jobs ‘created’ by the mine extension would have to come from somewhere, and this was not included in the analysis presented.

And even if the impact estimates were more accurate, Justice Preston noted that input-output modelling is at best only a partial input to the decision making process about whether or the costs of the project outweigh the benefits.

“The deficiencies in the data and assumptions used affect the reliability of the conclusions as to the net economic benefits of approval. More fundamentally, however, the IO analysis does not assist in weighting the economic factors relative to the various environmental and social factors, or in balancing the economic, social and environmental factors.” (judgement para 451)

“It provides, therefore, some information but only on one set of matters relevant to be considered by the approval authority in determining the project application. The IO analysis is not a substitute for the decision-making process that the approval authority must undertake in determining the project application, and the conclusions the IO analysis reaches cannot be substituted for the fact finding, weighting and balancing of all of the relevant environmental, social and economic matters required to be considered by the approval authority. The conclusions the IO analysis reaches on the economic benefits of approving the Project, evaluated for their reliability and given appropriate weight, need to be balanced against all other environmental, social and economic benefits and costs.” (judgement para 463)

These limitations reduce the effectiveness of these models in forecasting the evolution of local economies, and in estimating the impacts of the changes that are affecting them.

General equilibrium modelling approaches
Computable General Equilibrium (CGE) modelling starts with similar economic flows data to input-output models but allows capital and labour to move and allows for demand and supply to respond to changes in prices. CGE modelling is designed to model the impacts of an external shock to an economy (a shock like a tax change or resource price change) to see what the economy looks like once the shock has been absorbed and the economy is again in equilibrium.

“CGE models allow for prices to change the relative use of different factors of production in the production of a good or service. That is, while input-output models are an attempt to explain how much wheat, energy, labour and capital is used to make bread a CGE model might be used to estimate the impact of a wage rise on the amount of labour used in bread production.”(Denniss 2012)

While superior to input-output modelling in being less prone to overstating impacts, weaknesses in model design and modelling methodologies bring other constraints.

“.. . standard versions of MMRF [an Australian CGE model] do not include substitution possibilities between material and capital inputs to production, constant returns to scale are imposed on all industries, workforce participation and employment are usually assumed to be a fixed share of the working age population and workforce participants, respectively.” (Gretton 2013)

The inability of CGE modelling to take account of substitution between material and capital inputs to production is a particular weakness when the models are applied to estimate changes in firm behaviour from external shocks like a new tax or a reduced water allocation. These types of shocks may well have a big impact on the material and capital inputs used by a firm, and excluding this adaptation from the analysis greatly weakens the robustness of the results.

Elasticity assumptions are crucial in driving CGE modelling outputs. They are not computable from the model but are important inputs into it. This means that CGE models are weak when applied to regions rather than nations, as they cannot take account of regional specialisations, like higher land or labour productivity, or different elasticities of supply amongst firms in a region compared with firms elsewhere.

CGE modelling is all about equilibrium, comparing the state of the economy at one equilibrium (before a shock) and then another (after the shock).

“One of the most important, and least understood, features of CGE models is that they assume that, in the long run, the economy will be in full employment and that the path that the economy follows has no impact on its long run destination. … the economy is assumed to “converge‟ towards a “well defined steady state‟ in the longer run. Put another way, the modelling starts with the answer for what the long run level of GDP will be and then tries to plot the course that the economy will follow from where it currently is to where they know it will end up.” (Denniss 2012)

This means that CGE modelling has to take an economy-wide view of the shock, mapping both ‘winners’ and losers’ at the new equilibrium point, but not mapping how either made the transition or how the transition is actually effected, or where in an economy (below the national level) the impacts will be dispersed.

Local production systems approach
The alternative to scaling down a national economic model is to build up a local economic model of the agricultural production system. While this approach is likely to be weak in its ability to track the flow-on effects and links between all the different parts of the economy (the strength of input-output and CGE modelling) it gives a much more accurate picture of the scale of activities along a local supply chain, and the responses to increased or decreased activity (a weakness of input-output and CGE modelling).

The local production systems approach set out here is based on an agricultural supply chain. The approach is based on the collection of data from local growers, handlers and value-adders on their scale of operations (including employment), the factors that determine this, and the main upstream and downstream links in the supply chain. A local production systems model can be used as the basis for estimating the impact on local economies of changes in farm production. The estimated impacts are based on the historical experiences of businesses over the last decade, a period which in Australia covers both low-production drought years and some high production years.

The first step is to map the most important supply chains in the area being researched, and in Australia a good overview can be prepared from the ABS Business Counts data series (ABS Cat 8165.0) when used alongside Census and agricultural production data. Industry networks and phone index listings and local knowledge should be used to build a more complete picture of the main businesses operating along the selected supply chains.

Once the main supply chain(s) has been mapped using readily available information, the survey/interview process for the key businesses in the supply chain(s) can be determined. For an agricultural supply chain this would look like:
• Growers/producers
• Contractors and freight
• Processor/packers
• Manufacturers
• Rural supplies/rural services businesses

The interviews need to explore how businesses in the supply chain have made (and are likely to make in future) changes to their operations under different climate, market and regulatory scenarios. The interviews should probe for how these businesses have managed their employment and contracting to ride out the peaks and troughs in their business cycles. With information on peak and trough activity levels it is possible to identify the thresholds that will make operators change the way they run their businesses.

The peaks and troughs data gathered from the businesses in the local supply chain(s) enables modelling of the impact of changes in activity levels on direct employment and flow-on employment and business activity.

I recommend that three scenarios be modelled:
• ‘Best case’ with historically high levels of activity, planting, cropping or water availability
• A ‘medium case’ with intermediate levels of planting or activity
• ‘Worst case’ with historically low levels of activity, planting, harvesting or water availability.

In running the calculations you will need to draw from the interviews done, or from other industry data applicable to your supply chains, to find the key activity ratios from historical performance data to benchmark the high, medium and low scenarios ratios that drive the modelling:
• Activity level (eg turnover or planting area) (best case, typical case and worst case)
• Local spend (best, typical, worst)
• Employment (full time and casual, best, typical, worst)
• Profitability (best, typical, worst)

The value in the modelling, and the contribution it makes to understanding community wealth and wealth being, lies in the ability to estimate the flow-on impact on local spending and supply chain employment across the three scenarios – and to do it locally.

In assessing different future scenarios for communities, the modelling helps understand the total contribution to a local economy of the supply chains that have been analysed. When the modelling is applied to more than one supply chain, it can be used to compare the net impact on local employment and spending of changes in each. So, for example, when adaptability in tourism businesses is included, expansion or contraction in visitor numbers or visitor spend can be modelled to estimate the impact on local employment and local spending, in the same way the changes in farm scale activity have been modelled in the examples above. The impacts of a ‘farming led’ or ‘tourism led’ future can then be compared, with the contributions from each supply chain better understood.

References:
The Socio-Economic Impact of Cotton on Cotton Catchment Communities in NSW and QLD Centre for Agricultural and Regional Economics, CARE 2008
Denniss, R, The use and abuse of economic modelling in Australia , Technical Brief No. 12 The Australia Institute, January 2012.
The Use and Abuse of Input-Output Multipliers, Economic Research Articles, WA Treasury March 2002
Australian National Accounts: Input-Output Tables – Electronic Publication, 2005-06 Final (Cat 5209.0.55.001), Canberra 2009
Gretton, P, On input-output tables: uses and abuses, Productivity Commission Staff Research Note, Sept 2013.
NSW Land and Environment Court Bulga Milbrodale Progress Association Inc v Minister for Planning and Infrastructure and Warkworth Mining Limited [2013] NSWLEC 48, http://www.caselaw.nsw.gov.au/action/PJUDG?jgmtid=164038

Transitions in rural Tasmania

Can Scottsdale make it as a ‘turnaround town’?

Northeastern Tasmania is a place of fertile chocolate brown basalt soils, good rainfall and a mix of mineral and timber resources. Scottsdale is the regional centre, a town of some 2,400 people a little over an hour’s drive from Tasmania’s second biggest city, Launceston.

With the rich natural assets of the northeast, Scottsdale has had a good run of economic opportunity. But a series of business decisions made hundreds of kilometres away have pulled the rug out from under the traditional mainstays of this rural community.

The district’s potato packing plant closed in 2002. This took 110 jobs with it, and left growers with one less option to add value to their product. And in 2012 timber giant Gunns went into receivership – a consequence of misreading market signals for global hardwood chip demand, overinvestment in Tasmanian forests and plantations, and a 30-year struggle over access to State-owned native forests. Two timber mills near Scottsdale had already been closed in 2010 and 2011, losing the jobs of their workers as well as many jobs in logging and timber transport.

On the positive side, regional opportunities are in:
• Irrigated agriculture
• Trail of the Tin Dragon tourism route
• Mountain biking recreational trails
• DSTO Scottsdale upgrades
• Cape Portland windfarm.

This confluence of pressures on a rural town is not unusual in Australia. What’s the future for this historically tight-knit community of survivors? There are some who want to see the return of farming as the economic driver, others are looking at health and aged services, others again at tourism. How might these scenarios play out, and how can the community visualise and assess them?

Our analysis of the latest business and demographic data for the town of Scottsdale in northeastern Tasmania shows that it is working its way through a major transition. If successful, the town will be able to turn around from a primary industries and manufacturing base to become a hub for high quality services.

The analysis is being done by us as part of a team of national experts in regional communities who are being funded in 2013 by the Rural Industries Research and Development Corporation to work with selected towns on pathways to “Securing wealth and wellbeing for rural communities” (www.rirdc.gov.au/research-projectdetails/custr10_DRC/PRJ-008426).

In recent years Scottsdale has seen significant changes:
• The town has a stable overall population, but a lot of movement, with over 10% of residents in 2011 newcomers since 2006
• The newcomers are in two broad age groups (younger families and near-retirees) and two broad income groups (lower incomes and small number with high incomes),
• The actual size of the labour pool has started to shrink, because the long-term resident population is aging with many crossing the magical 65 line to formally retire. More people of younger working age will be needed to keep the labour pool active and supply the workforce that the town’s businesses will need in the future.
• While 150 plus jobs were lost from primary and processing industries in Scottsdale, almost half that number were created in service industries like hospitality, public services and health and aged care. Scottsdale’s employment diversity is increasing, while the population is stable – hallmarks of a turnaround town.

So what does the future hold for Scottsdale? A toolkit for the community which will enable various scenarios to be played out in ‘windows on the future’ was presented to a community meeting on 11 September this year. There was a very positive response to the approach, and we hope that this positivism translates into a good number of people completing the survey that is currently being run in the town.

The scenarios we will test cover:
1. Resurgence in agricultural (production and employment) led by capturing opportunities from new irrigation infrastructure;
2. Higher levels of tourism in the district – leading to more tourism businesses, employment and visitor spending;
3. Population changes such as more retirees moving in, or more low income families moving in, and
4. Growth in the breadth of health and active aging services in the community.

The community survey is the next critical step, as it will provide tangible evidence of residents’ perception and expectations, which will be processed through our choice modelling partners to identify the tipping points and thresholds that will either keep people in Scottsdale or trigger them to leave.

The modelling enables us to see what types of people are most influenced by each characteristic of the community, and we are then able to show how that influence will play out. So, for example, if young families are most influenced by the continuation of the high school, then we can model in the demographic impact of the loss of some young families should the high school close. This lets the community see the flow on impacts of real local decisions.

Each of the four scenarios can then be evaluated to see what the short term and long term impacts on the community will be. It will help the community work out just what the potential gains might be from a resurgence in agriculture (how many jobs, what sort of people), or from tourism, or from an influx of retirees. This will help the community see how a mix of changes will play out across Scottsdale, and whether or not the trade-offs from growth in one area will compensate for losses that are expected in other areas.

Booms and busts, what does the future hold for Mackay?

I’ve been in Mackay again this week, my third visit in about 5 years. And what a great place it is and what an interesting period it has been. Mackay is the regional service centre and port town for the Bowen Basin, an area with large volumes of coking (metallurgical) and thermal (steaming for electricity generation) coal.

Mackay is a standout “muscle town”, a moniker that was coined, I suspect, by well known demographer Bernard Salt, who is very good at finding a catchy name for a demographic phenomenon.

A muscle town is one that has seen rapid growth through a role as regional centre servicing a large mining area. So it is not the mine-site village. It is the ‘big smoke’ a couple of hundred kilometres away which has become the port (often literally) through which a mining region or a mining basin is accessed, and through which a vast amount of people equipment flowed during the construction phase of our current boom. I have added another aspect to the identification and definition of a muscle town – as being a place where population growth has not been accompanied by economic diversification. Instead, the economic mix (as measured for example by the spread of employment across different industries) is in fact narrowing, as growth is concentrated in just one or two dominant industries. This aspect makes it easier to identify statistically when a growing area might be categorised in this way.

In 2008 the data I had for Mackay was showing a rapid increase in net population, with new housing growth barely keeping up with demand. This was the early stage of the infrastructure investment phase of the mining boom when expansion of the Bowen Basin coalfields took off in response to strong world demand and very high coal process. By 2011 the rate of population growth had slowed somewhat in Mackay and its two neighbouring local government areas (where much of the actual mining was taking place) from 3%pa over 2001-06 to 1.4%pa over 2006-11. In that decade, however the region grew by almost 25%, with 34,000 new residents, and Mackay local government area itself grew by 27%, adding some 25,000 new residents. In just a decade that was a major growth spurt, cementing Mackay’s role and capability to be a regional services centre and one of the largest non-capital city populations in Queensland, being bigger than Gladstone and Rockhampton, and not far behind Cairns and Townsville.

High growth is a good problem to have, but the shortlist of woes in 2011 included rents and housing prices that were “way too high”, and an undersupply of housing in neighbouring areas (closer to the mines themselves). That undersupply was pushing people to live over the border in Mackay where housing was still available, and then drive-in drive-out to work. And high prices for in demand goods and services like motel rooms and hire cars which were making the tourism sector too expensive for actual tourists. The accommodation and services sector had moved to service transient workers rather than tourists. My message to the community was to be careful, to monitor the driver of the boom (mining expansion) knowing that growth would at some stage peak and then start to slow, and, if possible, for businesses not to have all their eggs in that particular basket. This was a difficult message to get across as many businesses at the time were stretched flat out keeping up with demand, with no time or inclination to think about managing different circumstances.

Two years later in 2013 I looked into the data and could see signs that the high growth period was slowing. Things like slower growth in employment and flattening of the number of new business entries in the area. But the community itself told me that I was 12 months late in my interpretation (probably right as the most up to date data I have is usually about 12 months old). In fact there’d been a sudden drop in mining related construction activity as early as mid 2012 as the big mining firms scaled back – particularly scaling back outsourced services and labour. Lay-offs and shrunk or cancelled contracts have become commonplace. And all this while the rest of Australia still debates whether or not the boom is over! I have no doubt that the next round of regional data available for Mackay will show more evidence of this – probably in falling employment numbers in mining, construction and mining services (or if not actually falling then a flatlining and end of growth), higher rental vacancy rates, lower prices for motel rooms and falling number of business entries and increasing number of business exits. Residents might even be able to get a plumber at short notice one day! We’ll see what the data says and I will write on this again to see if my fairly obvious predictions are correct or not.

In a broad economic sense diversification is seen as a hallmark of long-term sustainability, but in fact there’s nothing wrong with a narrowing of an economy through a boom time, so long as there is an understanding that this kind of growth is unlikely to continue, and that the players in the economy (businesses and government) are always looking ahead over the horizon to plan what they’ll do when the growth industries falter. Economics is known as the dismal science, and that is why economics almost always predicts that rapid growth like that described will at some stage falter. In the mining game the boom-bust cycle is based on demand-induced price rises which, in a free market world, will send prospectors and investors scurrying around to find and develop resources that have now become profitable. This behaviour gets repeated across all prospective areas from the Congo to the Bowen Basin, often with a common pool of international capital behind it, so that in due course new supplies come on stream to benefit from the higher prices. If demand does not continue to grow as fast, prices will fall back to longer term trend levels. In this highly simplified world view, each resources boom will be followed by a bust.

So a muscle town whose growth is built on rapid expansion in the resources sector and will at some stage see a slowing of growth in activity in that sector. And at a later stage the rest of the local economy will play catch up to bring the kind of diversification that is needed for the long-term future. This has been a cycle since the gold rushes in the mid 19th century and we should be used to it, but we tend to get caught up in the excitement of the upswing, and then to grumble and complain about the downswing. One of the best success stories I’ve come across in managing this cycle is from Ballarat. In the 1920s the town went into a slump (exacerbated by the big drop in gold mining activity after the turn of the century) and a group of wealthy townspeople decided to invest part of their gold profits into local manufacturing infrastructure. They invested well, and this local solution helped insulate the town from the worst of the Depression in the following years, and it started to grow again.

There are few mechanisms available to communities these days to salt away the profits from the good times and use them productively to avoid the lean times. Wealth generated by mining directly is repatriated to the international investors that bankrolled the capital investment needed to get the mine going. It is up to the locally-owned second tier assets of property, savings, superannuation and shares to fund investment in alternative economic infrastructure, and it takes a brave local investor to risk their capital in local projects these days.

What does the short-term future hold for Mackay?
The business community in Mackay is getting worried about an impending downturn. Will the lay-offs continue? Will many workers leave? Will turnover of non-mining businesses fall, and housing prices collapse? I don’t think the impacts in most parts of the economy will be too severe, and it will be important for the business community to retain some confidence, and not to talk the town down into a spiral.

Our model of mapping the impacts of an external shock – like a drought (this post) or in this case a drop in mining industry investment, suggests that it helps to categorise businesses into those more or less linked to mining activity, and those that are selling more or less essential goods and services. As mining volumes will stay high in the Bowen Basin, all the businesses providing support to the mines’ volume related operations will continue to do quite well – trucks will still run, tyres will be replaced, hydraulics repaired. But those businesses providing other services which are less related to production volumes and more related to expansion or more optional mining add-ons will be hit early and hard. Businesses providing mining construction equipment or services, surveying, labour hire and perhaps even training. The mining companies will be cutting costs by scaling back expansion activities and will most likely bring back in house some of the labour-related services they had to outsource when demand outstripped their ability to provide these services in house.

Beyond the mining-related businesses, the businesses in the Mackay economy providing daily and weekly essential goods and services will see their revenues capped by resident numbers and disposable income. So the behaviour of people laid off will be critical – will they get a redundancy, how will they spend it, and will they stay in Mackay or move on elsewhere? Some well-targeted research will be able to answer these questions, and with some data in the bag it would be possible to prepare a reliable map of what will happen through the regional economy over the next year or two so businesses can plan ahead.

Good information and good planning is the best way to avoid panic and stress in the wider business community. It will also ensure that confidence in the future means employers in less-affected industries will be able to offer the jobs that some of the laid off boom-time workers will be looking for to help them stay in the region. That’s a win for both sides, and a sound locally-driven response to smoothing out the peaks and troughs of being a muscle town.

Here’s a copy of the booklet on the region’s economy that we did for the Mackay Regional Chamber of Commerce Mackay Economic Report final

What will decent broadband bring to regional communities?

While there is some disagreement between the Labor and Liberal parties in relation to how high speed broadband should be rolled out across Australia, they both agree that they will subsidise this important infrastructure. Both parties have made this promise on the basis that it will give an economic boost to regions, as well as improving the efficiency of service delivery. Is there any evidence for this?

Firstly, better connectivity is a two way street – likely to bring both winners and losers. The ‘high speed’ tag for internet traffic reminds me of road traffic, and I get the sense that digital capacity is bringing the same challenges to local economies that sealed roads did in the 1960s and 1970s. Everybody wants the roads improved, but the improvements inadvertently helped retail and service consolidation in centres and reduced the diversity of small town main streets.

The digital capability jump is bringing the same two edged sword, allowing local suppliers to sell global and local buyers to buy global. Jack Archer, General Manager – Research and Policy at the Regional Australia Institute (RAI), agrees, writing that “If you are competitive and have a great product it is easier to expand your reach but if you don’t geographical barriers to entry may be much lower [for competitors].”

One difference between broadband and sealed roads is that broadband enables services to be traded too – not just goods. Many websites offer easy access to professional services for one-off jobs from providers around the world. This brings regional businesses access to top flight professional services, but it’s not hard to imagine this extending into legal, and financial services and potentially taking the rug out from under many long term local providers too.

Secondly, I’m convinced that improving hardware alone (connectivity infrastructure) is not enough. There’s been some good work by the EU of late on sequencing investment in various kinds of infrastructure (education, transport, digital communications etc) that shows that it doesn’t pay to get any one of these too far ahead of the others. Canberra got ‘fibre to the node’ in the early 2000s and there was a great expectation that the arrival of the big pipes would itself drive digital business explosion. But it didn’t, one or two firms led by world class entrepreneurs did very well from the pipe arriving a year or two before similar capacities were available in other cities, but that’s about all.

There’s been some great research in the US on this issue – availability, take-up and application of faster connections. One study showed that across US regions, those with higher rates of broadband adoption (measured by the percentage of households that have a broadband connection) had higher income growth and better rates of business formation. But there is a chicken and egg problem here, as high adopting regions may well have already been on a path for higher income growth. So to look for causality, the researchers compared ‘like with like’ regions by looking at growth rates in regions with similar ‘before broadband’ economies, differentiating between regions that had high take-up rates versus those with low take-up rates. The results here still showed that there were gains from adoption in terms of higher income growth, and better unemployment and business formation outcomes. But the differences are quite small.

“Non-metro counties that had high levels of broadband adoption (greater than 60%) in 2010 had significantly higher growth in median household income – 23.4% versus a little over 22% – between 2001 and 2010 when compared to counties that had similar characteristics in the 1990s but were not as successful at adopting broadband.”

The US recession in the decade studied (2000-10) means that the other indicators (unemployment and business formation) were all on a ‘less bad’ basis – as most counties showed higher unemployment and lost businesses over the decade. So the impact of better broadband adoption was less bad unemployment growth and less bad loss of businesses. And again the differences were modest.

A significant finding that relates to the ‘build it and they will thrive’ philosophy is that this research found that:
“Interestingly, when we repeated this analysis for levels of broadband availability (versus adoption), there were almost no results to report. The only positive result was that when very high download speeds were available (greater than 10mbps), the growth in creative class employment between 2001 and 2010 was larger. All other measures related to simply providing broadband showed no significant differences between the two groups of counties.
These results tie back to our suggestion from the previous article in this series that government policies dealing with rural broadband may need to have a more explicit focus on actually adopting (and effectively using) the technology. The traditional focus of these programs on simply providing infrastructure may not be enough to encourage true economic growth.”

Will broadband help?
I think the short answer is yes, though the likelihood of net gains (factoring in some expected economic losses) will be better if:
1. Availability is matched by adoption
2. Adoption is matched by effective use
3. Effective use is linked to world class entrepreneurship.

The applications are many and varied, and it’s not just about retail and service delivery. Applications in health and education are important, and the SenseT project in Tasmania is using data gathering and diffusion to help in businesses as diverse as vineyards and orchards (microclimate and other sensors) and oyster growing, where biosensors can provide “a real-time, perspective of the behaviour, welfare and health of the animals that combined with environmental conditions including water temperature and salinity will enable farm managers to make better decisions for the short and medium term management of commercial stock”.

Successful regionally-based internet retail businesses do exist already, (www.birdsnest.com.au is one), and readers will probably have examples from their own regions too.

What we are lacking in regional Australia is the grass roots help to potential entrepreneurs to make effective use of faster broadband, and to turn that into long term business success. Regional small businesses are already at a disadvantage in not being surrounded (physically, at least) by the same ‘entrepreneurial soup’ found in metro hot spots.

The technical support infrastructure too is an important part of extracting the most from broadband availability. It’s hard to measure, but as a starting point RAI has included workers and businesses in ICT in the Technological Readiness Theme of [In]Sight – Australia’s Regional Competitiveness index. This shows the levels of expertise available in different communities, and results are available for any Local Government Area or RDA at http://www.regionalastralia.org.au.

The web itself can overcome the physical isolation of working in a regional setting, and can bring access to world class business building services, but I think that entrepreneurial acumen and the strength of the local entrepreneurial ecosystem is going to play a more important role in business growth in the web-based future, not less.

How resilient is a local economy? Part 1

 Assessing interdependence

In the previous blog post I wrote about some of the pros and cons of a ‘buy local’ approach to economic development. ‘Buy local’ is all about the community getting the most out of the money circulating around it.  Can more money circulating help insulate a local economy from what economists like to call ‘economic shocks’?  In this post I’ll look at one way of assessing vulnerability to these shocks.

Most regional economies have one or two industries that bring money into the community.  These are usually agriculture, tourism, mining or manufacturing.  Service sector industries are also good at bringing money in – either through the sale of professional or technical services to customers outside the region, or through the services they provide to low income people who draw a pension or benefit.  But the high value service (tertiary) industries are found mostly in the cities, and while they do provide a good range of employment in regional economies, they play a smaller role than the primary and secondary industries (agriculture, forestry, fishing, mining and manufacturing).

The primary and secondary industries are quite exposed to external shocks like drought, flood, price drops and changes in the value of the Australian dollar.  In 2005 colleagues and I investigated the impact of the drought on non-farm businesses in two small towns, in an effort to better understand how the effect of an economic shock might work its way through a small economy.

The interviews we did indicated that the core issues for non-farm businesses were not surprising:  loss of cashflow, extended credit provisions, loss of skilled staff, and limited ability to secure business finance.  While everyone in the towns knew that “things were bad”, on closer analysis it became clear that in fact the extent of the impact on a non-farm business depended very much on the nature of the business. After considering the interview findings across business types and towns, we developed a simple model that takes into account the two drivers of drought impact on non-farm small businesses that were consistently nominated by interviewees. The model divides businesses into four types along two intersecting axes:

1. Reliance on producers as customers; and

2. Extent of ‘essentialness’ in goods or services sold.

Interestingly, we also found that the impact also depends to some extent on the determination and creativity of the business owner.

The Figure below presents the model graphically.

A Model of Drought Impact on Small Business<

BYFG quadrants

Our interpretation from the interviews was that the most intense drought impacts were felt by the rural support businesses in the 2nd quadrant – small businesses that are highly dependent on farmers but that also sell goods and services that can be “done without” when money is tight.  This interpretation is based on consistent feedback that the ‘inner circle’ – the ‘bedrock businesses’ – see a drop in turnover in drought but manage to maintain some (lower) level of sales.  The distinctive feature of this group is that sales of some product lines continue even when production and harvesting levels are low. For example, some items of heavy machinery are still turned over, and some farmers typically take the risk and invest in preparing soil and planting crops in the hope that conditions will improve and they will get a harvest. It seems there is a suite of products and services that farmers and non-farmers buy (to some degree) whatever their circumstances, and that these purchases buffer the direct drought impact on the bedrock businesses.

Quadrant 3 businesses also reported lower turnover, but were maintaining the lower level of activity despite the persistence of the drought in 2005.  The Exceptional Circumstances payments went some way to topping up the spending from farming households, and households with workers in other industries were not seeing such significant income drops.

Quadrant 4 businesses were an interesting mix, with most scaling back but one or two taking a risk and transforming their businesses to maximise profitability in a period of reduced demand, or at least of changed demand.  The jeweller in one town, for example, had changed their stock mix and introduced some new payment models to reflect a pattern they’d noticed for less frequent but occasionally more expensive purchases.

Here are some examples of business in the four quadrants:

BYFG examples

When we did this work we felt that the simple model reflected the reality of non-farm businesses in the towns.  While the feeling around the towns, and the conversations on the street, were that “the drought is killing the town”, in fact the businesses really struggling were limited to those most reliant on farm activity.  And with activity falling away there was much less demand for services to do with planting, cropping, grading or distribution.  We also noted that the Exceptional Circumstances payments available to farmers in those areas, while not large amounts of money, in fact did add to a fair proportion of what might be an ‘average’ farm household income – thereby further dampening the immediate impact of the lack of farm level activity.

While there was certainly not a feeling of buoyancy in the towns, the businesses in quadrants 3 and 4 were showing (out of necessity!) enormous ability to flex their operations around reduced demand.  This is the world of regional small business, where good times and hard times follow like the seasons, and a hallmark of long term survival is being able to expand and contract to match demand.  My favourite quote from that work was from a farmer who characterised his experience that there would always be cycles, and that he was prepared for these to a reasonable extent, but not to an unreasonable degree, with some laconic words…

“There’s nothing worse than drought following a couple of dry years …”

While the drought has passed, the high Australian dollar has been the latest economic ‘shock’ to have a serious impact on regional farming, fishing, timber and manufacturing businesses.  It is highly likely that the next challenges will be a gradual fall in mining-related construction activity – which will take the heat out of those regional communities running strongly in mining and mining services.  A fall in the value of the Australian dollar should help other exporters – and may even bring back some of the domestic tourists who have recently been holidaying overseas.    We are currently working with the community in Scottsdale in northeast Tasmania on their transition caused by the loss of hundreds of jobs in logging and timber processing.

So the pattern of external shocks is bound to continue, and a question for another blog is whether or not survival is the goal, whether resilience and bouncing back is what regional economies should be aiming at, or whether transformation is in fact inevitable – transformation into a local economy that has less to do with the strengths of the past and more to do with the opportunities of an uncertain future.

With many changes of Departmental nomenclature since the work was done, the website that held a link to the Drought Impacts Beyond the Farm Gate study is long gone.  I’ve attached a copy to this post.

regional_2005-04-13_Beyond_the_Farm_Gate

Is ‘buy local’ past its use by date?

Most small and medium sized towns run ‘buy local’ or ‘shop local’ campaigns from time to time. These are based on the feeling that money spent locally circulates around the community and brings a bigger flow-on benefit to the local economy than money spent outside. Incidentally, we see the same arguments at the national scale too, when Gerry Harvey complains that international internet shopping is reducing his profitability. I often get asked what the ongoing value of a dollar spent locally might be, and this post explores that question.

The ‘shop local’ rationale is better developed in the US than in Australia, and on my bookshelf is a well-thumbed copy of a book called “Going Local” by Michael Shuman – which doesn’t have a magic multiplier number but does have a wealth of good ideas on what works. Another great source of ideas and easily implementable actions is http://www.growinglocaleconomies.com, with a good set of resources on local economic development and entrepreneurship.

The best thing about the US work is that it recognises the link between the feel-good aspects of buy local, and the need for top-flight entrepreneurial capabilities as well. Some years ago the underlying principles of many economic development practitioners in the US shifted from ‘help for the business’ to ‘help for the business owner’, the entrepreneur. There are many discussions about the differences between owners and entrepreneurs and that is a great topic for another blog post in future!

The entrepreneurship resources available from the US are fantastic, with four of my favourites being
http://www.kauffman.org – business and community entrepreneurship
Economic Gardening – including good updates on the growinglocaleconomies site
Centre for Rural Entrepreneurship – good resources and a good monthly newsletter too
http://www.NxLevel.org – training programs for entrepreneurs

The Kauffman Foundation Energizing Entrepreneurs program has been leading this work on small town entrepreneurship for many years. Their package even has a presentation template to help win over Councillors reluctant to embrace the need to stimulate entrepreneurship – with the package then going on to provide lots of templates to actually engage business owners and foster entrepreneurship.

What’s the connection with ‘buy local’? Essentially, fostering entrepreneurship at the same time addresses head on the main gripes about shopping local: range of goods/services weaker than outside of town; prices generally higher than out of town; service too often falling short of expectations.

Without addressing these very real gripes, a shop local campaign is just window dressing. If local business owners are not up to the mark in terms of really understanding the needs of their customer base, then no amount of feel good campaigning is going to get the locals back in their doors.

What’s it worth to a local economy? It would be great to have a headline statement along the lines of ‘every $100 spent locally yields a net gain of $xxx across the local economy’ but no one in Australia has really been game to stand up and quantify it yet. There’s good article in Time magazine here which quotes from a UK New Economics Foundation study that asserts that 1 pound spent by a council with a local supplier (note that it is a service supplier not just a retailer of something imported into the town) is worth 1.76 pounds to the local economy, but only 36 pence if the 1 pound is spent out of area. These are bold claims, but they do have a sound methodology! I heard of one town where businesses included a coloured token with each transaction over $10, and starting with 500 tokens distributed across local businesses proceeded to watch and track where the tokens ended up to get their own measure of how local spending circulated.

The key thing in the UK study for me is the distinction between buying a product locally and buying a service. It seems that the service supplier (selling skills and the application of those skills) is more tightly integrated into the local economy than the wholesaler or retailer who buys in their products, markets and sells them, and employs people in the process. The net value to the local economy here is really in the wages paid to local staff – the rest of the business turnover covers the cost of goods coming in and going out again. This why neoclassical economists tend to lump shop local in with tariffs and other protectionist measures which, theoretically at least, can lead to lost efficiencies in the local economy if buyers end up paying ’too much’ for stuff they could have got elsewhere.

While trade in products like this is a consideration, the real prize in the US campaigns is shopping locally for products grown or made locally. The ‘value added’ in production of these does accrue in the community. Young Shire in NSW is doing very well with this at the moment, turning its Hilltops local food and wine brand into a catalyst for Town Hall dining and entertaining extravaganzas showcasing the best that the region produces. There’s a link to their newsletter at the bottom of this article.

But beware the local cultural cringe – the flip side of pride in local business capabilities. I’ve seen many highly skilled people operating in small towns whose clients all lie well outside the region. One was a global IT player in Dungog in the lower Hunter Valley, who was excluded from any tenders sought by the local council on the basis that he ‘couldn’t really be as good as he says or why else would he be based in Dungog’? A great example of the small town cultural cringe that some leading regional small businesses still find themselves up against!

In the US there’s also a strong undercurrent of shopping locally at local owned and independent businesses – again on the expectation that these businesses are better at circulating the money. The American Independent Business Alliance is very keen on buying local (www.amiba.net). There’s even research to back it. The Louisville Independent Business Alliance (LIBA) found that $55 of every $100 spent at a local merchant will be reinvested back into the community, as opposed to only $14 of every $100 for national chain businesses. I think that’s a big call as even the local outlet of a national chain business pays local staff and probably some local business service providers.

But Louisville still has an eye on reality in its shop local campaigns:
“I understand the feeling out there that ‘only rich people can afford to buy local’” says LIBA Director Jennifer Rubenstein. “No one I know of (not even our staunchest board members) buys local all the time, every time. Hence the slogan of Buy Local First instead of Buy Local Always.”

So is ‘buy local’ still relevant, or is it past its use by date?

In my view the concept is definitely worthwhile: local dollars are valuable and collectively do make a difference. And promoting local capabilities can help minimise the ‘local cultural cringe’! But I think the old style feel-good shop window campaign is not what’s needed, and is well past its use by date. In running a shop local campaign, communities should ensure that there’s a strong component of business engagement and learning, so that what’s on offer really does meet or exceed local customers’ expectations. See if the campaign can be used to also bolster improvements in customer awareness and customer service amongst local businesses. The worst outcome of all is where a well-intentioned campaign ends up over-promising to local customers and then under-delivering!

What have your experiences been?

hilltops newsletter no 01